US STRATEGY - MIXED SIGNALS

There appears to be a bit of waning upside momentum, but the daily pattern of higher-highs and higher-lows remains intact. The S&P 500 closed down 0.5%, with volume up 3.3% day-over-day. Breadth declined significantly with the advance/decline at -2353 to -992.

The US MACRO data points continue to come in with a mixed message. On one hand, the durable goods report was positive for the third month at 0.5%, though slightly below expectations of 0.6%. On the other hand, housing continues with a string of disappointments as new home sales hit a record low. The February new home sales were 308,000; lower than consensus 315,000 and down from a revised January report of 315,000. The Census Bureau estimate of new houses for sale at the end of February was 236,000, which represents 9.2 months of supply; up slightly from 9.1 months in January. Overseas, Fitch’s downgrade of Portugal created increased sovereign debt concerns.

The Dollar index had another strong day improving 1.2% and is down slightly in early trading today.

The VIX was up 7.3% yesterday, the biggest up day since February 4, 2010. The VIX continues to be broken on all three durations - TRADE, TREND and TAIL.

The Financials (XLF) was the only sector to close up on the day. The XLF was driven by the banks with the BXK +0.4% on the day. BAC is leading the money center names higher after the company announced that it would start forgiving mortgage loan principal for homeowners who owe more than 120% of their homes' value. MBIA and Genworth Financial were the two best performing stocks in the XLF.

Despite the disappointing news in housing, the S&P 500 Homebuilding index rose +1.9%; the third straight daily gain. LEN reported a much smaller loss than expected and said that it is on track to achieve profitability in fiscal 2010.

Crude was down 1.6% following a larger than expected build in crude inventory. Yesterday, crude broke the Hedgeye immediate term risk management line, so we sold out of our position in the USO. With Global Sovereign Debt risk mounting, we don't get paid to hope oil holds support.

Yesterday, gold prices are trading lower nearing a six-week low as continued negative Euro zone news lifted the dollar. In early trading, copper is trading lower also as the dollar is trading higher.

In early trading, equity futures are trading above fair value, in an effort to reverse yesterday's declines. As we look at today’s set up the range for the S&P 500 is 17 points or 0.7% (1,160) downside and 0.5% (1,174) upside.

Today's MACRO highlights are:

weekly jobless claims

Bernanke testifies on the FEDs exit strategy

weekly natural gas inventories

Howard Penney

Managing Director

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03/25/10 08:12 AM EDT

Professional Forecasting

“We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

-John Kenneth Galbraith

I have that quote scotch taped on the insert of my investment notebook. I keep it there not to remind myself how wrong the consensus groupthinkers tend to be, but to always remember that I don’t know what I don’t know. Mr. Macro Market knows all.

I have never been afraid to shoot the puck or make a call on markets. You can call that brave or arrogant. I call it strapping it on every morning and playing the game to win. For any of you who have done anything at the highest level in your life, you get this. Confidence beats cowardice.

What gives me confidence is my investment team and market prices. Before I make a call on anything out there, I check with what Mr. Macro Market tells me to look at, then I ask my analysts what they think. That’s it – we start each day by admitting that we may not know what market prices are telling us.

Every three months, we change our Top 3 Macro Investment Themes. Why do we change them? Well, that’s easy – because market prices change. We get a lot of questions on where we will wash out on our Q2 Macro Themes. We are waiting until the seconds run out on the game clock for Q1 to do that.

Any professional athlete, entertainer, or investor worth their title wakes up every morning reviewing their performance. Sometimes people don’t like others talking about performance. Sometimes people appreciate accountability. But no matter where you go in the morning, there your performance will be.

By next Thursday, my Macro Team’s performance will be on the scoreboard for Q1 of 2010. While I myself have made plenty of tactical mistakes out there, I think my teammates have performed admirably on nailing down 3 big macro moves. As a reminder, our Q1 macro calls have been:

Buck Breakout (bullish on the US Dollar; bearish on commodities, gold, euro, etc…)

Chinese Ox In A Box (bearish on Chinese stocks; bullish on Chinese yields and currency)

Rate Run-up (bearish on US Treasuries)

My biggest question every morning is where do our macro themes start to go wrong. The score is the score. What matters from here is what to make of it. Am I becoming consensus? Where do I sell the US Dollar? Should I cover my short position in gold? Should I short Chinese stocks again, or should I be long them?

Well, the good news is that my business model allows me to change my views on all of this with a click of a button. The conflicted and compromised ratings models of the Investment Banking Inc. can’t do that for you but I, like the buy-side, can. We call that cool.

Becoming consensus isn’t cool. Neither is not knowing that you don’t know that consensus can remain longer than you can remain solvent. I have learned this lesson plenty enough times in my career to never disrespect it.

US Dollar is overbought anywhere north of $81.92 on the USD Index. The big breakout line (support) is the immediate term TRADE line at $80.45.

Chinese stocks got spanked again last night, trading down -1.2% on the SSEC, and breaking my immediate term TRADE line of support of 3034.

US Treasury rates blasted right through every line of resistance I have in my macro models yesterday, across durations.

The least consensus call we have left is that rates are going to continue to Run-up. As a reminder, our call on US interest rates going higher is fairly straightforward and it’s based on 3 forecasts:

The Data – we think inflation (CPI), globally, will accelerate sequentially in March vs. February. We think unemployment rates (including the USA) are setting up to drop, sequentially, for the next 3 months, and that reported global growth will continue to surprise to the upside.

The Decision – Bernanke is preparing to remove the “extended and exceptional” language from consensus policy.

The Debtor – whether USA’s The Creditor be China or the US taxpayer in California, Piling more Debt Upon US debt Upon Debt from here is bearish for government bonds (we are short IEF and MUB).

Here are three fresh quotes that support our forecast for higher interest rates, globally, this morning:

Sovereign Debt - “Our financial support demonstrates our commitment to finding a fair and equitable solution for all stakeholders in the wider interest of the economy.” -UAE Supreme Fiscal Committee chairman, Sheikh Ahmed Bin Saeed Al Maktoum, on bailing out Dubai World at a price.

Sovereign Debt - “in an emergency, such aid would have to be provided as a combination of the International Monetary Fund and joint bilateral measures in the euro zone.” –Germany’s Merkel on pushing the Greeks to higher lending rates at the IMF.

Sovereign Debt - “We have clearly underestimated the impact on the euro from the European sovereign crisis and perhaps also from the broader macro adjustment that it portends.” –Goldman Sachs, capitulating on their bullish view of the Euro.

At least someone at Goldman is admitting that they too don’t always know what they don’t know. Cheers to professional forecasting. If you want to get in this game, be prepared to win and lose - because everyone, whether they like you personally or not, will be keeping score.

My immediate term support and resistance levels for the SP500 are now 1147 and 1177, respectively.

SJM's project to transform its Guangzhou Hotel into a slot-machines parlour was been granted approval by the Gaming Inspection and Coordination Bureau (DICJ) as an initiative to promote businesses, hospitality and tourism in the Inner Harbour. This was a surprise since the government "stands firm" on moving slot-machines parlours out of residential areas. According to DICJ’s director, Manuel Joaquim das Neves, no other locations in the Inner Harbour has been approved to open slot machine venues.

COTAI SANDS READY TO SHIFT macaubusiness.com

On Monday, March 29, Sands China will hold a contract signing ceremony with a contractor to restart construction on parcels 5 and 6 on the Cotai Strip. The actual start date of the construction is TBD. Phase I of the project is expected to be ready in 18 months and will cost approximately US$2 billion.

At the end of 4Q 2009, the Gaming Sector had 44,020 employees, up slightly by 0.4% YoY. Analyzed by occupations that are directly related to betting services, 18,274 were dealers, up slightly by 0.4% YoY; 12,040 were hard & soft count clerks, cage cashiers, pit bosses, casino floor persons, betting service operators, etc., up by 1.4%. Meanwhile, 5,283 were casino & slot machine attendants, security guards, surveillance room operators, etc., up by 4.4% from a year earlier.

In December 2009, average earnings (excluding bonuses and allowances) for full-time employees dropped by 3.4% year-on-year to MOP 15,100. The average earnings for dealers fell by 4.9% over December 2008 to MOP 13,270, and that for hard & soft count clerks, cage cashiers, pit bosses, casino floor persons, betting service operators, etc. stood at MOP 18,400, down by 5.7%. The average earnings for casino & slot machine attendants, security guards, surveillance room operators, etc. registered a YoY increase of 4.7% to MOP 10,060.

At the end of December 2009, number of vacancies of the Gaming Sector increased by 48.1% YoY to 382, with 114 for dealers, 57 for hard & soft count clerks, cage cashiers, pit bosses, casino floor persons, betting service operators, etc. and 66 for casino & slot machine attendants, security guards, surveillance room operators, etc.

With respect to the indicators that measure the inflow and outflow of human resources, as well as staffing needs of the sector, the employee turnover rate and recruitment rate of the Gaming Sector were 4.1% and 4.9% respectively in the fourth quarter of 2009, while the job vacancy rate was 0.9%.

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Early Look

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MFS's Pozen Discusses Financial Regulation Overhaul

Inflection Point In Swaps

We are short Municipal Bonds via the etf MUB, short High Yield Bonds via the etf HYG, and short Treasuries via the etf IEF

We have had our Hedgeyes on the action in the swaps markets over the last few days. Below we’ve attached five year charts for both 10-year swaps and 2-year swaps. These charts show that that swap markets are at an inflection point and, in fact, are turning negative. Last night, 10-year swaps were at -2.25 basis points and 2-year swaps were at -17.0 basis points.

According to Josh Steiner, our Financials Sector Head:

“Essentially, what’s going on here is that the cost of swapping floating rate obligations for fixed rate obligations has soared, which has put downward pressure on the fixed payer swap rate – so much so that the rate is now actually below that of comparable duration treasuries creating a negative spread (for the 10YR).”

This of course happens for a couple of reasons. First, it shows increasing anxiety around the Fed tightening. In effect, one would only pay a big premium to swap fixed rates for floating rates if you thought floating rates were about to get meaningfully more expensive. Secondly, and also per Josh:

“To a lesser extent it supports the idea that AA corporate credit is trading tighter and tighter to US sovereign credit, partly because the markets are starting to price in the downgrade of the US and partly because corporate balance sheets, especially for the financials, are much, much stronger now (i.e. they are holding significantly higher capital than at any time in the last several years with much of the credit risk already reflected).

The view that the Fed may raise rates sooner than expected from the swap markets has also been supported today by data points from the Treasury market. The Treasury Department today sold $45 billion in 5-year notes at 2.605%, which was a higher rate than anticipated. In addition, the buyers offered to purchase only 2.55x that amount being sold, which was the lowest level of demand in this auction since September 2009. Moreover, indirect bidders, a group which includes foreign central banks, bought only 39.6%, the lowest level since July.

We continue to be aggressively short this Rate Run Up.

Daryl G. Jones

Managing Director

Five-year chart of 10-yr swaps:

Five-year chart of 2-year swaps:

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03/24/10 04:01 PM EDT

SBUX – It’s Only Just Begun

SBUX held its annual shareholder meeting this afternoon and although the tone of the meeting focused around the progress SBUX has made over the last year, CEO Howard Schultz began his presentation by saying “there is no finish line and we are not shouting victory.” He concluded by saying, “It’s only just begun.”

SBUX’s annual meeting is a big event. Today’s management presentation ended with a performance by Sheryl Crow, who admitted to being a Starbucks groupie (her babysitter is an ex-barista). Among all of the razzmatazz, I’d say the two most important takeaways stemmed from management’s comments about its initiation of a quarterly dividend and its current growth strategy.

Earlier today, SBUX announced that its Board approved its first ever quarterly dividend of $0.10 per share and a resumption of its share repurchase program. Management stated that this dividend and increased share repurchase authorization reflect the true health of the company and show the strength of the company’s balance sheet. Management refuted the idea that the initiation of the dividend is a sign that the company is no longer going to grow. Instead, the company said that this is far from the truth as SBUX still has significant room to grow given that the company currently has less than 4% and less than 1% of market share in the U.S. and International coffee markets, respectively.

Mr. Schultz outlined the company’s significant growth opportunities, but said SBUX will pursue a “radically reframed growth strategy.” The company will maintain its traditional growth vehicle by resuming growth of its U.S. store base while accelerating the growth of its International stores. The new growth will come from the company’s pursuit to make its coffee available in multiple platforms in multiple formats, primarily through expanding the CPG business, Seattle’s Best and Starbucks VIA. Specifically, Mr. Schultz thinks that both Seattle’s Best and VIA are multi-billion dollar global opportunities. VIA is currently sold in 10,000 outlets and the company thinks the brand can easily achieve 30,000 points of distribution. Internationally, SBUX sees big opportunity for VIA as 70%-80% of all coffee consumption is in the instant coffee category. SBUX just launched VIA in the U.K. about three weeks ago.

SBUX thinks it can fill a gap with Seattle’s Best by making premium coffee available to customers in more places. There are currently 560 Seattle’s Best cafes in the U.S. and the company plans to grow the concept through both new company-owned units and a franchise network. According to management, there is a deep pipeline of franchisee perspectives. This retail store growth will complement the brands growth through the CPG channel and through partnerships with other retailers, such as the recent announcement to roll out Seattle’s Best coffee in Burger King’s 7,000 units in the U.S.

Mr. Schultz is convinced these new avenues of growth will complement SBUX’s retail business growth. And, he predicted that over the next 2 years, “a different kind of Starbucks will emerge.”

Howard Penney

Managing Director

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